A worthy alternative to bonds: private debt

These fixed-income strategies are designed to offset volatile markets while offering stable yields higher than those of most bonds

By: DIANNE MALEY

Date: February 15, 2017

This RRSP season, as you cast about for bond alternatives to plump up the fixed-income side of your portfolio, consider a private debt offering from an alternative investment manager.

Now, “alt” investing might evoke images of risky algorithms dreamed up by quantitative analysts, or vulture funds picking over the bones of distressed companies. Ideally, though, debt strategies are designed to offset the ups and downs of the stock market while offering stable yields that are higher than those available on most bonds.

Here are a few favoured by Craig Machel, a portfolio manager at Richardson GMP in Toronto who specializes in alternative investments.

Until recently, alt investments were the preserve of “accredited” investors – individuals with high income and a high net worth. Changes have made alt investments available to investors of lesser means whose investment adviser is also a portfolio manager.

Bridge financing

David Sharpe, chief executive officer of Bridging Finance Inc. of Toronto, clearly loves the role his firm plays providing short-term financing to small and mid-sized borrowers who may not meet bank lending requirements.

Mr. Sharpe, a member of the Mohawks of the Bay of Quinte First Nation near Deseronto, Ont., says his firm has become the “go to” group for bridge financing to First Nations, a burgeoning market for infrastructure and economic development.

“We’re one of the first calls in Canada for this type of thing,” Mr. Sharpe said in an interview. “It’s an important and growing part of our business.”

A lawyer by training, Mr. Sharpe also teaches a course in First Nations negotiations at Queen’s University in Kingston, Ont. “Consultations with First Nations about economic development is gigantic in this country,” he says. “We want to be on the leading edge of that.”

Among Mr. Sharpe’s proudest achievements was providing interim financing for a new commercial centre – a supermarket, drugstore and retail space – for the Elsipogtog First Nation in New Brunswick, creating 50 jobs in the process. Already, the supermarket is netting $1-million a year, he says, and community members no longer have to drive 20 minutes to buy a loaf of bread.

The project had been years in the making, says D.J. Joseph, Elsipogtog nation administrator. “We were coming down to the wire when the idea was brought to us that we could secure the financing through a bridge financing company,” Mr. Joseph said in an interview. “Bridging Finance was the one that secured the capital dollars to get things going. We couldn’t have done it without them.”

With deal flow robust, Mr. Sharpe is “looking forward to consistent growth in 2017” despite uncertainty over the recent U.S. election. “The economy is alive and well in this country.”

The Sprott Bridging Income Fund LP is diversified by sector and geography, he notes, “and we’re getting deals in interesting places,” from Nunavut to Newfoundland. Among the projects financed were the purchase of two fishing vessels for an Inuit organization called the Baffin Fisheries Coalition and a tomato processing and canning plant in Leamington, Ont.

Mr. Sharpe is chair of the board of governors of the First Nations University of Canada in Regina and a board member of the economic development corporation for Eabametoong (Fort Hope) First Nation near Thunder Bay, Ont. He runs the fund with his wife, Natasha Sharpe, who is chief investment officer. She has PhDs in epidemiology and community health. Both have MBAs.

All of the Bridging Finance loans are performing, Mr. Sharpe says, which means no one is behind on their payments. “Private debt is very hard work,” he adds. “You have to roll up your sleeves, do your due diligence and monitor your investments.”

The Bridging Finance fund is marketed and distributed by Sprott Asset Management of Toronto. Bridging Finance acts as subadviser. The Sprott Bridging Income Fund LP (Class F) returned a net 8.07 per cent to investors in 2016, Mr. Sharpe says. The fund has returned a compounded 8.95 per cent a year since inception in November of 2013.

Private mortgage pools

If there’s one thing investors want in this era of low interest rates, it’s yield, and they are finding it in alternatives such as private mortgage pools, where investors pool their money in a limited partnership to lend to developers, secured by real estate.

“Yield is an incredibly hot topic,” Mr. Machel says. Among his list of favoured firms in the private mortgage area is Morrison Laurier Mortgage Corp., formed to invest in the portfolio of Morrison Financial Mortgage Corp.

“It doesn’t pay the most, but they’ve never lost a dime,” Mr. Machel says.

On its website, Morrison Laurier says it specializes in financing mid-sized construction projects based on verified pre-sales. In its 28 years of originating and managing mortgages, Morrison Financial has had no investor losses and an uninterrupted distribution stream, the firm says.

Other mortgage managers on Mr. Machel’s list include Trez Capital of Vancouver, which specializes in short-term commercial mortgage lending, and Centurion Asset Management Inc., which invests in real estate through the Centurion Apartment REIT. Another pool, the Centurion Real Estate Opportunities Trust, invests in mortgages as well as “opportunistic” real estate developments. Non-bank lenders make up about 10 per cent of the mortgage market.

Long-short bond strategies

Fixed-income hedge funds can be complicated and their returns lower than higher-risk commercial lending, but they can offer safe, stable returns to investors concerned about preserving their capital. Although bond markets tend to be populated by big institutional investors such as pension funds, they’re also a harbour for nervous nellies fearful of the ups and downs of the stock market.

Seldom has the outlook for bonds been so uncertain. Bond prices tend to move in the opposite direction to interest rates, so if and when interest rates show clear signs of a sustained rise, prices of longer-term bonds will fall. Just last month, Bank of Canada governor Stephen Poloz said another cut in the central bank’s benchmark rate was possible because the economy is vulnerable to trade tensions with the United States.

South of the border, though, market watchers – with some exceptions – believe the American central bank, the Federal Reserve, will continue to raise rates slowly but steadily.

In these circumstances, what could be better than a bond strategy designed to make money no matter what interest rates do?

Toronto-based RP Investment Advisors LP has strategies designed to do just that, Mr. Machel says. Through a handful of funds, RP managers look to take advantage of inefficiencies in the vast, opaque, global bond market, both investment grade and high-yield. Currency risk is hedged.

Another of Mr. Machel’s mainstays is the long-short funds offered by Picton Mahoney Asset Management of Toronto. The firm offers several stock and bond strategies, as well as one publicly traded closed-end bond fund, the Picton Mahoney Tactical Income Fund.

On its website, the firm says the fund provides exposure to a diversified portfolio of income-producing securities that are long or short high-yield and investment grade bonds. The fund posted an average annual return since inception on its Class F units of 4.21 per cent.